Stocks & Markets

How a Rising Yuan Could Affect U.S. Investors

U.S. investors have plenty of theories about the eventual impact of China's new currency policy: A higher yuan could boost commodity prices, encourage U.S. exports, control Chinese inflation, and spark U.S. inflation. Yet, investors say, it won't do any of these things soon.

The People's Bank of China said on June 19 that it would "enhance the renminbi exchange-rate flexibility," allowing the value of the Chinese yuan to rise. The currency has been set at an artificially low level to facilitate Chinese exports.

It's a move that China's trading partners, especially the U.S., has long solicited. "The [currency] peg has created imbalances globally," says Michael Church, president of Addison Capital Group.

The Chinese government gave few details on its new policy or how rapidly it would be implemented. Few observers expect quick moves.

In China, "economic policies are rarely changed in a dramatic fashion," Wells Fargo (WFC) global economist Jay Bryson said in a June 21 note. "Rather, Chinese officials prefer to move in a very deliberate fashion to minimize the probability of negative shocks to the economy."

The announcement returns China to a policy that had previously boosted the value of its currency by 21 percent against the dollar over a three-year period, from 2005 to 2008. The yuan was pegged to the dollar in 2008 to protect Chinese exporters when the global financial crisis struck.

Overseas, stocks rose; U.S. dipped

Even if the financial impact of a stronger Chinese currency is slow to appear, the mere announcement can ease market tensions. "Anything that helps promote a healthy relationship between China and the U.S. is important for the global economy," says Sandy Mehta, principal and chief investment officer at Value Investment Principals.

Major European and Asian stock market indices closed higher on June 21 while in the U.S., major market benchmarks were narrowly lower. The Standard & Poor's 500-stock index was off by 0.39 percent.

Although commodity markets were mixed on June 21, some observers expect a yuan revaluation to eventually push prices of oil, metal, and other materials higher. "The long-awaited announcement [has] improved the outlook for commodities," wrote Wicktor Bielski, an analyst for VTB Capital, in a June 21 note.

Mehta agrees. "With a stronger currency, the Chinese can buy more commodities," he says, potentially benefiting U.S. energy companies.

Chinese companies can buy other things, too—including foreign companies, real estate, stocks and other investments. "You'll see acquisitions being made all across the spectrum," says Randy Bateman, president of Huntington Asset Advisors. Key targets for Chinese mergers and acquisitions, he says, could be companies specializing in energy, materials, or technology.

Higher costs for U.S. retailers

In the U.S., evidence of Chinese M&A interest could boost stock values. So could the prospect of higher profits from exports. A stronger currency could help develop China's consumer market as the yuan enables the Chinese to buy more products from the U.S. and elsewhere, Lincoln says. In particular, he says, there could be demand for consumer and health-care products.

At the same time, a higher yuan is "probably a negative for the retail sector in the United States," Bateman says. Wal-Mart (WMT) and other American chains rely on cheap imports from China. Those retailers will find it harder to keep prices low while maintaining profit margins if currency changes make those goods more expensive.

Then again, labor unrest in China, where factory workers have been demanding—and winning—higher wages, may already be raising the prices of Chinese products, Church says.

The Chinese government didn't say what prompted its policy change, but labor unrest and the closely related threat of inflation are considered key drivers. "It's about China realizing they need more tools in their monetary policy tool kit," says Gerald Buetow Jr., chief investment officer of Innealta Capital. A currency that trades more freely "allows them to address their inflation problems."

This could be a turning point, Church says, in which China gets its own inflation under control while raising prices—both of commodities and its exported manufacturing goods—for the rest of the world. "This is the beginning of a long process where China stops exporting deflation and starts exporting inflation," he says.